What Works for Agricultural Nonpoint Source Pollution Reduction? Evidence from the Corn Belt in the United States

This paper joins the non-point source pollution regulation discussion and examines whether economic incentives provided by crop insurance subsidies alter fertilizer application decisions in the direction with environmental benefits. The model predicts that farmers regularly apply more fertilizer than optimal in a given year to take advantage of yield gains in the few years with favorable weather conditions, and that the long-term optimal fertilizer application level reduces with crop insurance, thus creating environmental externalities. Intuitively, farmers use “insurance application” of fertilizer at their own full expenses to achieve exceptional good yields and profits to make up for losses in bad years to sustain long-term profitability. With insurance covering the loss in very bad years, such incentive is reduced, resulting in a reduced the long-term optimal fertilizer level. Empirically, this study finds that a reduction in fertilizer use was achieved in the search of reducing systemic production risk in agriculture via crop insurance. An Instrumental variable (IV) approach was used taking advantage of the exogenous shocks on crop insurance enrollment induced by Federal Crop Insurance Reform Act (FCIRA) of 1994 and the differential response to the policy due to past extreme heat shocks. The study finds that counties in the Corn Belt where cropland is dominated by corn and soybean production showed an 18.5% decrease in commercial nitrogen (N) fertilizer use. No significant change in phosphorus (P) fertilizer application was found. The difference in behavior responses between N and P is expected and can be explained by the natural process of N and P in the soil and history of nutrients management in the Corn Belt. These findings suggest that public programs that alters economic incentives can have significant knock-on effects on agricultural non-point source pollution. Further, effective design of economic incentive programs in regulating agricultural NPS pollution should be rooted in understanding natural process of the pollutants in the ecosystem. More broadly, policy targeting the same population, regardless of the designed purpose of the programs, should be considered when predicting policy outcomes.